The real estate market is changing. As we reach year-end this year, Colorado is continuing to see a strong housing market, with prices continuing to rise year-over-year even though interest rates remain high. A good portion of closings are using a Buyer’s Rate Buydown to help mitigate the high interest rates for buyers. This helps bring the nearly 8% mortgage interest rate down to a more reasonable interest percentage, thereby lowering monthly payments. Let’s take a look at what a Buyer’s Rate Buydown means for both the seller and the buyer.
What Is A Buyers Rate Buydown?
A Buyer’s Rate Buydown is a one time fee paid at closing which takes a percentage of the closing price to reduce the mortgage interest rate. This fee is called either Mortgage Points, Discount Points, or Prepaid Interest Points. Once this fee is paid, the interest rate for the loan term is lowered.
In another form of Rate Buydown, buyers can arrange to have the rate lowers for a set term of the loan, and after which time the interest rate would revert to today’s percentage. This allows the initial fee to be less.
In 2023 these Mortgage Points or Prepaid Interest Points are typically paid by the seller as a concession to closing. This allows buyers, especially first-time homebuyers, the ability to purchase these high priced homes in Colorado at decent rates which we have grown accustomed to over the past decade or more.
What are Mortgage Points?
Mortgage Points, Discount Points, or Prepaid Interest Points are “a one-time fee you pay to lower the interest rate on your home purchase or refinance. One discount point costs 1% of your total home loan amount. For example, if you take out a mortgage for $100,000, one point will cost $1,000. When you purchase a point, you prepay the interest for a smaller monthly payment.*” Once these points are purchased, a buyer can utilize these points in exchange for a rate reduction on their mortgage. On average, and this largely depends on the lender so make sure to shop around, lenders will reduce a mortgage interest rate about 0.25% per Mortgage Point.
Costs To Reduce Interest Rates.
Interest rates are currently sitting at around 7.9%, depending on the lender, credit score, and down payment. In order to reduce that interest rate down to pre-2023 rates, you’d need at least a 3.5% reduction. In order to get the 3.5% reduction, you would need about 14% of the price of the home in Mortgage Points. The median cost of homes in the Denver Metro Area is sitting around $585,000. This means you would need $81,900 to pay as the one-time fee to reduce the interest rate over the duration of the mortgage.
This fee is on top of the down payment expected from buyers. Sellers recognize that with high interest rates, high prices, and inflation woes are making buyers hesitant to purchase properties at listed prices. To help instigate closings, many sellers are negotiating mortgage interest rates with Mortgage Points and paying this one time fee upon closing. This is not a price reduction on the property, and does not affect the close-price-to-list-price ratio. Oftentimes lenders will utilize the equity on the property to buy the Mortgage Points and pay the fee to reduce a buyer’s mortgage interest rate. This is one of the concessions that is rising in popularity in real estate transactions since the end of 2022.
Types of Buydowns
Buyers Rate Buydowns act, in a way, similar to ARM loans, where there is a reduced interest rate at the beginning of a the loan term and the rate adjusts later on. Unlike ARMs, buyers know exactly what rates they will see in the future, the time frame before the rate increase is much shorter, and the rate reduction comes with a fee of Mortgage Points. Here are the typical buydowns mortgage lenders may offer:
Full-Term Buydown
This is the most standard form for Buyers Rate Buydowns. Once the rate is purchased, the reduced interest rate percentage is extended for the loan term.
1-0 Buydown
In this instance, the buyer reduced their mortgage rate for the first year by a set percentage, and after that year is over, the mortgage reverts back to the interest rate before its discount.
2-1 Buydown
A 2-1 Buydown allows the first two years to be at reduced interest rates, and on the third year the rate reverts back to the interest rate before its discount. The first year is typically at a lower rate than the second year, allowing the buyer to scale payments over a few years before arriving at the full interest rate and mortgage payment.
3-2-1 Buydown
This is the least practiced type of buydown, but like the 2-1 buydown allows for buyers to scale their mortgage payments over time before arriving at the full interest rate and mortgage payment on year 4.
If you’re looking to buy a new home but feel deterred due to the high prices, this may be the best option for you to get into a new home. Speak with your local mortgage lenders and your Realtor to start the process to buydown the interest rate on your mortgage. As a seller, be prepared to field requests to help buy down prospective buyers’ interest rates to help move your home, especially if you’re in a saturated market. If you’d like to discuss more options for your real estate venture, get in touch with us today!
*Kielar, Hanna; Rocket Mortgage, “Mortgage Points: What Are They, And Should You Buy Them?” August, 17, 2023
